HISTORY AND PROSPECT OF THE NIGERIA GOVERNMENT BONDS MARKET

Amount: ₦5,000.00 |

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1-5 chapters |




ABSTRACT

The study focuses on the development of government bond market in Nigeria. It explores the history,  structure, performance  and key issues related to the development  of bond  market with the broader context of domestic,  regional and global bond market  development.  The Nigeria  government  bond  market  provides  valuable  lessons  for  other  emerging  market economies also seeking to build bond market. The sophistication of the local bond market is not enough  to make  it appealing  to foreign borrowers.  Market  development  demands  an enabling market  infrastructure  and a background  of  macro-economic  stability,  diversified market participants, an appropriate regulatory and supervision environment.

CHAPTER ONE INTRODUCTION

1.1      BACKGROUND OF STUDY

The   current   administration’s   commitment   to   rebuilding   Nigeria’s   dilapidated infrastructure as a catalyst for economic development has brought to the fore the need for a functional bond market given the developmental needs of the economy. The recent period of economy growth witnessed in Nigeria can only be sustained with continuous investment in infrastructure and the expansion of industrial output. The  dearth of adequate financing has been  identified  as  one  key  factor  inhabiting  this  much  needed  investment  in  critical infrastructure such as down and mid stream petroleum distribution, telecommunication and transportation. Additionally, substantial long term financing would be required to rejuvenate Nigeria  ailing  power  sector,  it  comatose  refineries  and  the  provision  of socio-economic development in education and healthcare. Moreover, recent effort by the FGN to diversify the economic and make it more market driven means that funds would also be needed to expand existing facilities to meet the increased demand expected of a more efficient economy over the long term.

The  Bond  Market  remains  a  fundamental  financial  market  as  risk  pricing  and investment  valuation models rely on its data. While a functional domestic bond  market is necessary  for capital  investment,  monetary authorities  also  use bonds to  define the  yield curve and to ensure stability of short-term rates. An active sovereign prevents the economy from overheating as it allows large temporary overflows from the money market. The Bond Market  therefore  plays such a vital role in ensuring  the  health of the economy that  the monetary authorities must be concerned with its structure and operation.

Internationally  best-practice  stipulates  the  existence  of  a  public  debt  managing agency. Until 2000, no such agency existed in Nigeria. Whilst the Federal Debt Management Office (DMO) may have eventually been instituted, debt relief provided a critical spur, and ensured it was provided with sufficient resources to achieve the country’s goal of debt relief. This meant that a strong, capable debt management agency was created more quickly, and with greater public support, than it otherwise would have been.

Nigerian  Bond  market  is  principally  regulated  by  the  ISA  and  the  Rules  and Regulations  of  the  Nigerian  Security  and  Exchange  Commission  (SEC).  Although  the Nigerian  Sovereign  Bonds  have  been  in  existence  since  the  1970s,  but  was  said  to  be inactive. Government issued paper was very short-term and limited in scale. Treasury bills had maturities of 91 days and below and this created inconsistencies and irregularities in the federal  government’s  borrowing  costs.  The  DMO,  in  a  bid  to  restructure  the  Federal Government   of  Nigeria’s   deficit   funding   from   shorter   to   longer   tenured   borrowing instruments,  improve and lengthen the yield curve in  the domestic money markets, and to encourage long-term savings, introduced the sale of Federal Government of Nigeria bonds in October 2003, with the launching of four Federal Government bonds of maturities ranging from three years to ten years. The bonds were sold to investors through all licensed banks and discount houses in the country. However, most of the investors adopted a “hold to maturity” approach and therefore little or no secondary trades were carried out.

The  DMO  extensively  restructured  Nigeria’s  domestic  debt  portfolio.  In 2005,  it commenced  a textbook bond market development  programme.  This began with the  initial issuance of 2 and 3 year bonds for which there was appetite, and gradually and predictably increased to issues of 5, 7, 10 and now 20 year bonds. However, the regular monthly issuance of the federal government bonds of increasing tenor generates a sovereign yield curve which serves as a benchmark for pricing other securities, including corporate bonds. This is a very powerful strategy to support growth by generating long term funding sources for government financed  development  projects  such  as  infrastructure,  but  more  importantly,  will  help  to realize the potential of Nigeria’s vibrant private sector to create wealth and jobs by opening this source of domestic funding.

In December 2004, the Nigerian domestic debt stock had an outstanding amount of N1,

370.32 billion, compared to the N1,329.72 billion as at December 2003. This figure had an increase of N40.63 billion or 3.1 percent over the previous year’s figure. This however, was the lowest annual growth in the domestic debt stock for eight years(DMO 2009).

This increase of N40.63 billion in the domestic debt stock was made up of new issues of Treasury Bills valued at N46.52 billion, which was partly offset by repayments of Treasury Bonds and FGN Development Stocks valued at N5.67 billion and N0.22 billion respectively.

As at the previous year (2003), the Treasury Bills remained the dominant instrument, accounting for N871.57 billion or 64 percent of the total domestic debt stock. The balance of

the total domestic debt stock was made up of Treasury bond (N424.94 billion or 31 percent), Federal Republic of Nigeria Government Development Stock (N1.25 billion or 0.1 percent) and the first FGN Bonds (N72.56 billion or 5.3 percent).

In the year 2004, the DMO made plans to build on the success of the first FGN Bonds floatation  that  were  first  issued  in  2003.  The  DMO  embarked  on  the  arrangements  to commence  the  issuance  of bonds on a regular  basis in small  tranches  that market  could accommodate.

The DMO commenced  the smoothening  and restructuring of the Treasury Bills  in

2004. The restructuring entailed extending the maturities of the existing Treasury Bills by issuing tenors of 6, 12, 24, and 36 months, to refinance part of the existing 91-day Treasury Bills.

The 2005 bonds issuance programme which had a floatation of N140 billion over the period  July to  December  2005,  had  the  objectives  of  restructuring  the  existing  stick  of Nigerian Treasury Bills into longer-tenured  bonds, and to help sustain the  momentum  of reviving, deepening and developing the Nigerian capital market (DMO, 2005).

The debt deal in 2005  not only removed  a significant  financial  burden  from  the government, allowing it to spend its resources on public service delivery and social sectors, but it enabled the DMO to refocus its energy on the core business of public debt management

– “establishing and executing a strategy to manage the government’s debt in order to raise the required amount of funding, pursue its cost and risk objectives, and to meet any other public debt management goals the government may have set, such as developing and maintaining an efficient and liquid market for government securities” (IMF and World Bank, 2002).

The next landmark in the development of the bond market occurred in August 2006, when   a   primary   dealership/market    maker   network   was   established.   The   Primary Dealers/Market Markers (PDMMs) are the only institutions authorized to deal directly with the DMO in bond auctions. The establishment of this system was to facilitate the emergence of a liquid and vibrant secondary market for government securities, in line with global best practices (DMO 2006).

Prior to the establishment  of the of the system, DMO requested for expressions  of interest (EOI) to the PDMMs in the FGN Bonds from financial institutions, of which a total of thirty-two (32) EOIs were received (DMO 2006).

The purpose of the PDMM system is in two-fold:

    To ensure the total take up at primary auctions of government bonds.

    To provide liquidity in the secondary bond market.

Apart from underwriting every bond issue, the PDMMs, are also required to  make two-way price  quotes  on the bonds to  their  customers  and  other  PDMMs  in  all  market conditions upon demand. This means there has been viable and vibrant  secondary market trading in FGN bonds issued by the DMO since August 2006.

The  strategy  for  the  development  of  Nigeria’s  bond  market  from  2008-2012  is organized  on  a  medium  term  basis  with  an  annual  securities  issuance  work  plan.  In developing this work plan, the Federal Government conducts wide consultations with market participants  through  regular  monthly  meetings  held  with Primary Dealer  Market  Makers (PDMMs), usually before each FGN Bond auctions. (DMO, 2008).

Bond issuance in 2008-2012 will continue to aim at developing the bond market and creating a benchmark for the issuance of other instruments. This will be achieved through the issuance of long-tenured instruments.  It also aim at providing low cost funding for the FGN, subject to the control of risks within acceptable limits, and developing the market for long- term  debt  instruments,  thereby  creating  a   benchmark   yield  curve  for  other  financial instrument in Nigeria.

The  Work  Plan  for  the  bond  issuance  programme  in  2008-2012  will  include advertisement   of  Offer  Circulars,   conduct  of  auctions,   post  allotment   activities   and development of indicators for domestic debt sustainability.

The 2008-2012 Bond Issuance will include the following features:

Following  the continued  sophistication  of the appetite  of the market,  a  variety of instruments such as floating rate and index-linked securities may be introduced;

With growing sophistication and capacity in the market and also in order to optimally allocate  government  resources,  the  multiple  pricing  auction   system  may  be introduced;

The FGN Bonds auctions, which are presently conducted monthly, may be made more frequent as demand for the bonds continues to soar, particularly with limitations on re-openings; and

The submission of bids will be done on the day and within a specified  timeline  or duration while settlement takes place on T+2.

The restructuring of short-term debt instruments to long-term will continue until the ratio of 25:75 short-term to long-term debt ratio is achieved. (DMO, 2008).

The curve of tenors on debt instruments has increased sharply and impressively in the six  years  since  the  launch  of  the  Access  Bank  government  bond  index.  Today,  the government has issued bonds with a 20 year tenor. This reflects the  growing confidence in the market’s capacity to absorb Government bonds and in the sophistication of the instrument to serve as a key conduit for state funding. While investors’ search for a stable asset class has proved a strong catalyst for the market’s  expansion, investors are attracted to government bonds for some technical reasons, such as their tax exemption status.

The corporate bond market is also developing, and this may be attributable to the need for inexpensive long-term debt capital by companies coupled with investors’ apathy to equity investments, following the impact of the global economic recession on the values of stocks. Companies including Guaranty Trust Bank Plc, UACN property Development Company Plc, United Bank for Africa Plc and Flour Mills of Nigeria Plc have successfully issued bonds in the Nigeria capital market while a number of other corporate bond application are before the Nigerian SEC.

The ISA does not specifically provide for the regulation of corporate bonds, thus the broad provisions  of the ISA regarding  securities  offering by a public  company  apply to corporate bonds. In addition to the general rules on security offering, the  SEC  Rules also stipulates certain requirements that apply specifically to corporate bonds. The SEC Rules on corporate bonds was one of the initiatives introduced to  encourage the development of the Nigerian corporate bond market.

To further encourage the development of the Corporate and State Government bonds as well as bond issuance by supranational institutions such as the International Development Bank, in March 2010 the Government  approved a waiver of taxes for  these categories of bonds. The taxes covered by the approval are the Personal Income Tax, Value Added Tax, the   companies   ‘  Income   Tax   and   the   Capital   Gains   Tax.   However,   the   requisite administrative  and  legislative  process  to give legal  effect  to these  waivers  are  yet to be concluded. It is expected that the waivers will be in place for a period of 10 years from the date of grant by the Government. Furthermore, the Nigerian banks are now allowed to treat

state government bonds as liquid assets provided such bonds meet the requirement stipulated in the CBN circular. (DMO Circular for USD500m Sovereign Bond Issuance, 2011).

In the thick cloud of financial uncertainty and apprehension, the guarantee offered by the bond market has become an attraction. At least in the bond market, investors have their capital and pre-agreed interest guaranteed against the vicissitudes of the financial market.

Bonds are an investment made (purchased) by lending money to whoever issue  the bond in exchange for future income in the form of interest payments. At the end of the life of the bond, the investor gets the original investment back, plus the interest on it. The interest payments  and  principal  (amount  of  your  investment)  are guaranteed  by  the company or government that issue the bonds.

State governments and even banks are now patronizing the market, competing with the federal government, which has been the dominant player in the market since  its origin. Among this states are Niger, Imo and Kwara State Governments which made their successful first entry in 2009 with an offer of N6 billion, N18.5 billion and N17  billion respectively (DMO, 2009).

1.2      OBJECTIVE OF THE STUDY

This study strives to evaluate the development of the Government Bond Market  in Nigeria. In order to achieve this general objective, the study however strives to achieve the following specific objectives:

i.     The evolution of the Government Bond Market in Nigeria

ii.      To  evaluate  the  key  success  factors  that  make  the  Nigeria  Government  Market successful.

1.3      SCOPE OF THE STUDY

The study analyses the performance of the Nigerian Bond Market as regards to FGN Primary Bond Issuance, FGN Secondary Market Trades, domestic debt growth trends and the transformation of the domestic debt stock by instrument.

1.4      LIMITATIONS OF THE STUDY

Access to data from secondary sources was difficult. As a result, the study to a large extent relied on statistics compiled from the Nigerian Debt Management Office, Central Bank

of Nigeria Statistical Data, members of the African Stock Exchange Association  (ASEA), Nigerian Stock Exchange facts books, IMF etc. As this is a working paper series, quantitative data hereby reviewed on annual basis.

1.5      SIGNIFICANCE OF THE STUDY

In most African Countries, the domestic bond market is generally under-developed in both breathe and depth compared to the banking system and the equity market. Because of the  experience  of  the  Asian  crisis,  many  studies  have  made  a  case  for  developing  the domestic bond market as an alternative  source of  debt financing  in cash strapped  Africa where general shortcomings are observed in terms of the variety of debt financing.

The rationale for developing a domestic bond market is that, firstly, it is an alternative source for debt financing. This decreases the over-reliance on bank lending for debt financing and minimizes  exposure of the economy to the risk of a failure  in the  banking  system. Secondary, these markets reduce financing costs through disintermediation. Thirdly, an active and efficient bond market would broaden capital markets by offering investors opportunities to invest in a wider range of assets. A  forth  consideration  is that the exercise of a well- functioning bond market can lead to the efficient pricing of credit risk, since expectations of all bond  market participants  are  incorporated  into bond prices.  Lastly,  a developed  bond market  supports  the  economy  in  meeting  its  financing  needs  during  periods  of  rapid economic growth (IOSCO 2002:3).

The Domestic Bond market is of benefit to the Nigeria Economy in the sense that it enthrones in more rational management of government’s fiscal and monetary operations. By funding its debt in the capital market and by issuing longer tenured securities. Government will further its economic reform program and help develop the nation capital market.

Also, the investors will benefit from the domestic bond market through following:

i.     The investment is “default risk-free”. ii.      Tax-free interest income.

iii.      Relatively high returns.

iv.      It can be used as a collateral security.

v.      It is fully transferable/marketable on the floor of the Nigerian Stock Exchange (NSE). vi.      Qualifies as a liquid asset for banks when two years to maturity.

Domestic  bond  market  debt  financing  is  required  for  many  projects,  including rehabilitation of the necessary infrastructural facilities in electricity generation transmission and distribution, the energy sector, road and rail transportation, telecommunications, portable water supply, socio-economic infrastructural facilities, etc. (SECC 2000:12).



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HISTORY AND PROSPECT OF THE NIGERIA GOVERNMENT BONDS MARKET

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